The following is our monthly correlations update for July. As we have stated time and again, correlations between different currency pairs will inevitably shift over time. Therefore, it is of utmost importance to keep abreast of these fluctuating relationships to fully understand your trades and portfolio. Below are the one-, three-, six- and twelve-month correlations for the seven major currency pairs. Additionally, we have included the six-month trailing correlation versus the EURUSD as further confirmation of the correlation.
In order to be an effective trader, it is important to understand how different currency pairs move in relation to each other. There are a few reasons why this is significant, but most importantly, it allows traders to understand their exposure. For example, having a portfolio that consists of the USDCHF and EURUSD is different than having a portfolio comprised of USDCHF and USDJPY. As indicated in the tables below, through the Monday of July, the Swiss economy’s depence on the EZ lead to a boost in the long negative correlation (-0.93) with EURUSD. On the other, the overbearing influence of risk appetite and the popularity of the carry trade evened out to lead the USDCHF and USDJPY positive correlation (+0.78) to falter. This means that having long exposure in both USDCHF and long EURUSD would generally negate profit or loss because when EURUSD rallies, USDCHF will sell off the majority of the time. Of course, these two currencies may have different pip values and the correlation is not perfect, so the P/L will not be exactly zero. On the other hand, holding long USDCHF and USDJPY positions would be similar to nearly doubling up in one of the pairs since the correlation is so strong. Furthermore, we can tell from our tables that correlations shift with time. For the past year, the carry trade has been a proiminent market driver; but we can seen in the correlation between USDJPY and NZDUSD that the impact isn’t as clear cut as it used to be. Over the past year, the level of US interest rates and the volatlity in interest rates led the pair to a positive correltion (0.33). However, through the past month alone, the sharp drop in the kiwi has completedly flipped the link (-0.59). Shifts such as these can be partially explained by changes in the severity of monetary policy or changes in unique domestic conditions. Overall, having this knowledge will allow traders to effectively diversify and manage their portfolios.
Regardless of your trading strategy and whether you are looking to diversify your positions or find alternate pairs to leverage your view, it is very important to keep in mind the correlation between various currency pairs and their shifting trends.
FX Correlations (data as of 08/01/08)
